What is PSI

PSI is income produced primarily from your own personal services, skill, or labour.

Income is classified as PSI when more than 50% of the consideration you receive for a particular contract or transaction is for your labour, skills, or expertise such as consulting, professional or other services. This regardless income was earned as a sole trader or through a separate entity rather than being employed directly by the customer.

PSI rules were introduced through the Alienation of Personal Services Income Act 2000, as an anti-avoidance measure to ensure an individual does not lessen or defer their income tax by diverting income received from their personal services through companies, partnerships, or trusts. The Act inserted Part 2–42 “Personal Services Income” into the Income Tax Assessment Act 1997. Subsequently, on 31 August 2001, the Commissioner of Taxation issued further Taxation Ruling TR 2001/7 The meaning of personal services income

The meaning of “income” for the purposes of PSI is wider than that which might otherwise be the case under the common law. Under PSI, income excludes any income generated from selling or supplying goods or services, such as retailing or wholesaling, or manufacturing, as the income will not mainly be a “reward for the personal skill, knowledge, and effort”. Also, by using income-producing assets, such as a truck, bulldozer, bobcat, or printing press and so, the majority of the work will be generated by these assets, and thus not affected by PSI rules.

How do the rules work?

Income is classified as PSI when over 50% of the consideration you receive for a particular contract or transaction is for your labour, skills, either as a sole trader or through a separate entity rather than being employed directly by the customer.

To be exempt from the rules, you or your entity need to be deemed as a Personal Services Business (PSB). You qualify as a PSB if you meet the Result Tests. You may alternatively qualify as a PSB if:

Less than 80% of your personal services income in an income year comes from one client and you meet one of the other three personal services business tests (the Unrelated Clients Test, Employment Test, or Business Premises Test), or
you obtain a determination from the ATO confirming that you are a personal services business.

*SOURCE: ANAO interpretation of information provided by the ATO – Australian National Audit Office*

The Results Test (The Primary test)

Taxpayers earning personal services income can self-assess whether or not they are a PSB if, for at least 75% of the income:

Are paid to achieve/produce a specified result.
Provide tools or equipment of trade (is applicable).
Be liable to rectify any defects in work performed.

If you answered YES to all above the questions, you are deemed to be a PSB and therefore PSI rules do not apply.

If Results Test fails:

If you don’t pass the Results Test, you can only move on to the next tests if 80% or less of your (or your entity) PSI comes from any one client AND you pass ONE of the below-remaining tests. However, if 80% or more of your income comes from one client then you are stuck, and the PSI rules apply to you unless you apply for a special determination from the ATO.

The remaining tests are: Unrelated Clients Test, Employment Test or Business Premises Test. You need to pass only ONE:

1. Unrelated Clients Test

To pass this test, you must:

Receive PSI from two or more “unrelated” clients who are not controlled by the same individual or entities.
Provide your services as a direct result of making offers or invitations to the public (e.g., through advertising, tenders)

Note that you do not pass the Unrelated Clients test if you source all your work through arrangements such as a labour hire firm.

If you answered YES to these questions, you are deemed to be a PSB and therefore PSI rules do not apply. If you do not pass this test, you can attempt the Employment or Business Premises tests.

2. Employment Test

To pass this test, you must either:

Have employees, partners of a partnership, or contractors perform at least 20% (by market value) of the principal work. The principal doesn’t include incidental work such as bookkeeping, issuing invoices, or running the home office. Or
Have one or more apprentices for at least half the income year.

If you answered YES to either of these questions, you are deemed to be a PSB and therefore PSI rules do not apply. If you do not pass this test, you can attempt the Business Premises test.

3. Business Premises Test

To pass this test, you must answer “yes” to ALL the following questions. Your business premises, must at all times of the income year:

Owned or leased by you
Used 50% or more of the time for personal services work
Used exclusively by you
Physically separate from any premises you use for private purposes
Physically separate from clients’ and their associates’ business addresses

If you answered YES to all parts of the Business Premises Test, you are deemed to be a PSB and therefore PSI rules do not apply.

Personal services business determination

All fail, taxpayers can apply to the ATO for a personal services business determination. This is available regardless of whether the taxpayer derives more or less than 80% of their personal services income from a single source.

The Tax Office, in making an assessment, will consider all and any unusual circumstances that stopped you from passing a test and if any one of the 3 tests could be satisfied in future income years.

If you pass PSI

If you meet one or more of these tests, your personal services income is taken to be generated in the course of conducting Personal Services Business PSB, and the PSI rules will not affect your tax obligations. If the Personal Services Income is paid to your company, partnership, or trust, rather than to you directly, then the entity is your personal services entity.

CAUTION

Passing all tests or qualifying as a PSB does not necessarily alienate the risk of tax avoidance provisions. If you or your entity is deemed to have entered into an arrangement where the main purpose was to obtain a tax benefit, for example by income splitting, then the general anti‐avoidance provisions contained in Part IVA of the Income Tax Assessment Act 1936 can impose severe penalties.

Fail to pass PSI

If you do not pass any of the tests and fail to obtain a determination from the ATO, then the tax implications mean:

INDIVIDUALS trading as Sole Traders: Will not be able to claim certain deductions against your PSI, including rent, mortgage interest, rates, or land tax for your home office Payments to your spouse (or other associates) for support work such as secretarial duties.
ENTITIES (Company, Partnership, Trust): Treat the PSI income received as belonging to each individual who performed the services, and each individual will need to declare that income in their tax return. The entity will not be able to keep the PSI income as part of its business profits and must also withhold PAYGW tax from the income that is credited to the individual unless the entity pays the PSI to each individual who performed the services as salary or wages.
Will also need to meet certain tax reporting obligations.

Note that the PSI rules do not deem contractors to be employees and do not affect the legal relationship between the contractor’s entity and the other parties they are dealing with. This means, if the PSI rules do apply, there will be no change in the contractual relationships with your customers – e.g., you don’t have to become an employee of the customer.

PSI rules and the applications of these tests can be very complex. Given the scope of the rules and the difficulty which many people have in working out if they are caught, it is essential that you seek professional advice.

By Gregory Atamian – JJN Associates Accountants Tax Advisors

The content and the references made in this article are correct as at the publication date and are for general information and should not be relied upon as advice. If you wish to seek particular advice, call us on 02 9997 4000.

REFERENCES:

The Auditor-General, Audit Report No.5 2013–14, Performance Audit – Australian National Audit Office(ISBN 0 642 81397 3)

Pennicott, Scott — “Resolving the Personal Services Income Dilemma in Australia: an Evaluation of Alternative Anti-Avoidance Measures” [2007] JlATax 2; (2007) 10(1) Journal of Australian Taxation 53

Post Implementation Review Into The Alienation of Personal Services Income Rules – The Board of Taxation – October 2009 – A report to the Assistant Treasurer (ISBN 978-0-642-74572-9)

LEGISLATION

The alienation of personal services income rules can be found under Part 2-42 of the Income Tax Assessment Act 1997 and in Division 13 in Schedule 1 to the Taxation Administration Act 1953 and took effect from 1 July 2000.

Part 2-42 of the ITAA 1997 contains Divisions 84 to 87:

Division 84 defines the term personal services income.
Division 85 limits the entitlements of individuals to deductions that can be claimed against personal services income.
Division 86 introduces rules governing the income tax treatment of personal services income paid to interposed entities, including deductions available against that income.
Division 87 determines when an individual or entity is conducting a personal services business. If they are a personal services business, Divisions 85 and 86 do not apply.

Division 13 in Schedule 1 to the TAA 1953 introduces pay-as-you-go (PAYG) withholding obligations for attributed personal services income.

DEFINITIONS:

*PSI Rules*	alienation of PSI rules, introduced on 1 July 2000 by the New Business Tax System (Alienation of Personal Services Income) Act 2000 inserting Part 2–42 into the Income Tax Assessment Act 1997. The PSI rules were introduced to prevent individuals reducing their tax by diverting income generated by their personal services to a company, partnership or trust and to limit work‐related deductions available in those cases
*PSI Tests*	a series of self‐assessment tests designed to determine the business status of an entity, and therefore whether the PSI rules apply to the entity’s personal services income
*Personal Services Income*	a business (sole trader, company, partnership or trust) that earns income from personal services and meets the results test or at least one of the four personal services business tests, and/or has a determination from the ATO stating it is a personal services business

SOURCE: The Auditor-General Audit Report No.5 2013–14